Audit Rotation (Essay Sample)

A debate about Comparison between the Rotation of the Audit firm and the Audit Partners
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A debate about Comparison between the Rotation of the Audit firm and the Audit Partners
Introduction
In an effort to improve on the independence, objectivity and professional scepticism of the public accountants, auditor's rotation is considered as one of the viable options. Auditor's rotation is an operational practice whereby the companies will be required to change the external auditor after a given number of years. Currently, there are no laws that require the rotation of the auditors in the public companies in the US and as well in the UK. However, the US and the UK companies are required to rotate the audit partners after every five years. Non-Public organizations are not required to rotate partners or the auditors either but instead ensure that a high-quality audit is performed.
The Public Company Accounting Oversight Board was appointed by the US congress to oversee the audit of the public companies and help to prevent the investors and other financial information users. The board has raised concerns over the long-term relationships between the audit firms and the organizations. They argue that the relationships can create laxity and diminishing objectivity and professional scepticism. Responding to the claim, the American Institute of Certified Public Accountant and the big four audit firms argue that the rotation will lead to a decrease in the quality of the audit. E & Y responding to the concern indicated that there is usually a learning curve in the first three years of audit. After this period, the auditors become conversant with the organizational practices and process and thus increasing the effectiveness and efficiency of the audit. The AICPA opposes the move owing to the unintended impacts and as well the high costs that will be involved (Bostrom, 2014).
In a letter to PCAOB signed by 31 large corporations and non-profit organizations, they argued that the audit rotation would harm corporate governance, diminish the audit committee roles and reduce the quality of the audit and consequently increase the cases of undetected fraud. The change will cause disruptions in the operations, thus increasing the costs doing business (Bostrom, 2014).
The call for the audit rotation is not only confined in the United States, on February 2014, the European Commission (2014) proposed a series of changes in the regulations of the audit. Amongst other changes, the commission proposed a maximum term of six years that an auditing firm can provide audit services to the organization and a hibernation of four-year before the firm can resume offering the services. The public organizations will be required to source for auditors in an open tendering process. The commission as well calls for the separation of audit and non-audit services. The commission argues that the 2010 crisis is an indication of the failure of the auditors and has translated to a decline in the investor confidence in the European Union. PwC one of the big four audit firm in its response argued that the mandatory rotation will increase the cost and at the same time lead to a decline in the quality (Journal of Accountancy, 2011).
These proposals were later amended to address the concern of the auditors and as well the business communities in general. The period was increased to ten years and a provision for an extension of up to 25 years if certain safeguards are in place. The proposal is however a subject to the approval of the Permanent Representative Committee and as well by the European committee (Journal of Accountancy, 2013).
In a recent development to the proposal, seven legal affairs committees opposed the move citing the interruptions, high cost and compromises on the quality. The committees also cited the interference to the freedom of contracts and decision making. This in particular will affect multinationals that rely on particular audit group for uniformity and consolidation purposes. The committees also view the proposal to have an audit committee as an interference to the decision making capacity of the organization ("European business rejects audit rotation | Economia").
According to a report by (Johnson et al., 2002) that sought to study the relationship between the length of the relationship and the quality of the audit. In the conclusion, they noted that there was no evidence to support the claim that long relationship result to compromises in the quality of the audit. The paper sought to understand whether the preconceived notion that audit rotation will improve on the quality and independence of the auditors is true or if it is just an illusion. On the contrary, the report showed no deterioration of the quality after the first four years. On the contrary, short-term audit contracts were the characterised by low quality. This is used to demonstrate that the debate on the auditors’ rotation is based isolated and anecdotal cases (Johnson et al., 2002; 640).
In another finding by (Naggy and Carcello, 2004), he sought to gain an understanding of the relationship between the audit tenure and fraudulent financial reporting. The General Accounting Office was required to study the effects of mandatory audit rotation. GAO concluded that this is not the most efficient way of enhancing auditor's independence. In the study, they investigated fraud cases from 1997 to 2001 and on the contrary, they found that the fraud was more prominent in the first three year of a new auditor. The report also pointed out that there were no evidence to support the claim that there was increased fraud owing to the long relationships with the auditors.
There are several studies that have been carried out in an effort to understand the impacts of voluntary and involuntary change of auditors. A case reference is the ex-Arthur Andersen clients. A study by (Raghunandan and Barua, 2010) revealed evidence of lags in the clients that did not move with their partners to their new offices. In the conclusion, the paper highlights the importance of the continuation in the audit. In another report, (Naggy, 2005) sought to understand the impact of a large client bargaining power over the audit firms. The paper focused on the ex-Arthur Andersen clients and demonstrated that there was an improvement on the quality following the changes. This however cannot be exclusively used to avert the position that mandatory audit rotation can improve the quality. This is so since the AA case had some unique characteristics. An example is the fact that most of the clients moved with the partners to other audit firms and that the fact that they changed once does not mean they are expected to change the auditors in the future.
Critical review of the opponents and the proponent points have been done. One such report by (walker and others, 2001) attempted to substantiate the claims by the regulators that the independence and quality are affected by the long-term relationships. The study also sought to substantiate the claims by the opponents that the quality would be affected and as well the costs. The study concluded that there is no evidence to support any of the claims.
Another research was carried out to compare the impact of the rotation of partners versus the rotation of the audit firms. The report found that even in an environment where strong controls are in place, like the case in the big four audit firms. The investor confidence was more boosted by the rotation of the audit firms as opposed to the rotation of the audit partners. The report concluded that the rotation of the audit firm had a better chance of enhancing the quality of the audit and as well the independence (Gates S. K. and others, 2007).
The discussions on the auditors’ rotation has not been confined in the US alone. In Spain, a study was conducted to evaluate the relationship between the long-term audit engagement and the opinion shopping. The research findings were that the longer the audit engagement is, the lower the chances of opinion shopping. Therefore on the audit rotation calls, the report concluded that quality and independence of the auditors is not affected by the tenure of the audit (Ruiz-Barbadillo et al., 2006).
Ways to Reinforce Independence of the Auditors
There are several ways that are being advanced to act as an alternative to enhance the audit rotation. The proponents of the audit rotation argue that it will lead to an enhancement of the quality and affirm the independence and as well the professional scepticism. However, the opponents argue that changes especially short-term rotations will affect the quality of the audit, there will be no industry specialists; it will disrupt global operations and undermine the companies' decision-making capacity. There are no evidence to support the thought that the audit rotation will reduce the market concentration. On the contrary, in Italy where audit rotation has been in place for some years, the market concentration has increased suggesting that the rotation may have been a contributing factor.
There are several alternatives to audit rotation that have been suggested. They include:
Audit Partner Rotation
As an alternative, audit partner rotation can reduce the over-familiarity with the management and thus enforcing the objectivity and professional scepticism. This at the same time does not increase the costs that are incurred in the changing of the auditors. The other benefit associated with this practice is the fact that the audit history and experience gained over the years will be available. The practice should be enforced and also be unified for uniformity and consistency. In the same argument over the familiarity of the auditors with the management is the fact that the companies’ management is never static. Studies have shown that the average tenur...